Tag Archives: Valuation

What is the Role and Value of an M&A Consultant? Four Points

Situation: The owners wish to sell a company. One option is an M&A consultant to assist with the sale. The CEO wants to know about others’ experience. What is the role and value of an M&A consultant?

Advice from the CEOs:

  • The first step is to assess the strengths and weaknesses of a consultant to determine their value.
    • The cost of an M&A consultant is inexpensive relative to the value of the business.
    • Accounting rules and M&A practices of public companies do not always apply to private companies. Valuation is affected by variations in profits year-by-year, so consultants typically use 3 to 5 year historical results for comparison against industry standards.
    • Technology companies may have a different value than service-oriented businesses, particularly if significant IP is involved. Look at the creativity of potential consultants’ solutions.
  • Consultant alternatives:
    • Business brokers, accountants, and valuation specialists can all offer valuations.
    • Investment Bankers who charge an upfront fee may be more strategically oriented. Typically, the more strategic the valuation exercise, the more dollars involved.
  • Be cautious in choosing a consultant.
    • Many business owners spend a lot of time and money with accountants and lawyers when they could save by working with a business broker paid on a commission basis.
    • Business brokers are skilled at getting business sold – however the deal is not necessarily in the best interest of the owner. Brokers are paid by commission and so may not have the best interests of the owner at heart.
  • What should you look for in a consultant?
    • Maximization of sale value with a minimal tax exposure.
    • A consultant who will help the owner figure out what they want from their business and exit – who will help to establish owners’ exit objective, a key to a successful exit.
    • A consultant who will help choose the right team of advisors.

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What’s Your Exit Strategy – Both Timing and Price? Four Considerations

Situation: A CEO is considering an exit strategy for the company that she founded. The company has been very successful, and the CEO wants to optimize the value of the company on sale. She seeks advice on how to both maximize the company’s value and how to best prepare for a sale. What’s your exit strategy – both timing and price?

Advice from the CEOs:

  • Value is tied to revenue and profit growth. Revenue growth is based on expansion of the customer base and reshaping the product offering to optimize its market appeal.
    • Consider a usage-based price for the offering. Accompany this with a range of usage offerings based on current customer use patterns.
    • Consider tiered pricing or pricing/use to access lower tiers of the market.
    • Consider bundled products, for example along with complementary products of another company with whom marketing partnerships could be formed.
  • As part of the valuation exercise, determine the best exit strategy and timing:
    • Identify the companies that could be buyers.
    • In each case, identify why they would buy the company.
    • The most compelling reason to purchase the company will be strategic, not financial.
    • Identify the key decision maker in each of the potential buyers.
    • Also identify any factors that would make the company less desirable to any potential acquirers and develop remedies for these.
    • This exercise may help to plan the timing and to understand more about the price that could be fetched.
  • To appeal to a buyer, optimize the organizational chart.
    • If the CEO occupies too many seats on the chart this presents a substantial risk to an acquirer if the founder leaves.
  • Evolve the organizational structure to support growth.
    • If there is no compelling reason to sell in the near term, then staff the company with professional marketing, financial talent, and so on.
    • A lack of talent in key positions limits both the company’s growth and its appeal to potential buyers.
    • In the case of this company, the most important hire will be in marketing. Note that marketing does not equal sales. The company is creating a market and convincing people to change their habits. This is a marketing task, not a sales task.
    • If the analysis of the factors mentioned above determines that now is time to sell, then stay slim.

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How Do You Prepare for Sale of the Company? Six Points

Situation: A company’s founder and CEO wants to sell the company. The company’s software is well-suited to current governmental priorities and should be of value to potential buyers. What are the best steps to take both to prepare for a sale and to sell at the highest price? How do you prepare for sale of the company?

Advice from the CEOs:

  • Add a person with connections to potential buyers to the board.
  • Look for an M&A specialist who knows the company’s market.
    • The right specialist will help validate the valuation of the company, review and identify potential purchasers, and make the inquiries that will lead to the sale of the company.
  • Investigate M&A cases in the industry and related technologies – both cases of firms like the company and cases of companies that may be suitors to determine their purchasing behavior.
    • This will help develop strategies to maximize the value of the company and the optimal bargaining position and will help prepare for negotiations.
  • Maximize the value of the company in preparation for the sale.
    • The fastest business growth may come from within the company’s current customer base – additional business customers where the company already has contacts.
    • Work up the food chain within existing customers to increase the company’s business within these companies.
  • Important preparations for a sale:
    • Assure that financial records are very clean. These are critical during the price-setting process and in negotiating the final price.
    • In computing company valuation, exclude the salaries of current principals to improve the income statement. These individuals will be replaced post-sale with lower-paid employees.
    • Continue to operate the company as though there will never be a sale. This maintains the value of the company regardless of what happens.
  • How open should be the company be – internally and externally – concerning a potential sale of the company.
    • Be as honest and open as is prudent. The biggest concern will be salespeople who may leave the company if they feel threatened by a sale, or who may stop selling because they do not want to try to explain the situation to prospects.
    • The other “at risk” group is developers, who may fear that they will be replaced or terminated following a sale and who may leave.

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What Is Your Exit Strategy? Three Options and Approaches

Situation: Every CEO needs an exit strategy, if only for the good of the business because the future is uncertain. In this case, the Founder CEO wants to reduce her involvement in the business over the next 3-5 years. Her company has an offering that addresses domestic and international concerns about global warming. The CEO seeks help evaluating options. What is your exit strategy?

Advice from the CEOs:

  • The CEO sees several strategic options. Which option is more likely to yield results in a timeline that fits a 3-5 year exit strategy – a major international push, a partnering strategy, or leveraging current business to gain additional sales and market share by tweaking the current product line?
  • International Strategy.
    • The company needs international partners, not just a sales presence. This will require substantial time and upfront commitment from the CEO, not just a salesperson.
    • Where and who are the predominant businesses in the international markets under consideration?
    • Can an international strategy be executed and produce fruit in time to complement the exit strategy?
  • Partnering.
    • Partner with a hardware company to increase visibility and usage.
    • Partner with some of the top prospects for an exit strategy.
  • Focusing on the Product Line.
    • Employ customer shadowing to better understand how customers currently use the software and what challenges they encounter or opportunities they see – involve marketing, and R&D, not just the sales team.
    • Reposition the current offering to take advantage of opportunities.
    • Simplify installation and implementation.
    • Look at the product development strategy. Can revenue be bumped or upgraded from renewal customers? Are there options for “deluxe” versions with a premium price for upgrades, that become the following year’s standard upgrades?
  • Gather the company’s team and work through the scenarios for these options. Once this is done, prioritize them based of timeliness and potential impact on the bottom line and company valuation.
  • Also look at the Board structure – are there gaps in regulatory or sales and marketing expertise. What about adding someone who has connections to a key customer base?

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What are the Key Points to Make in an Investor Presentation? Three Views

Situation: A CEO wants to raise money to expand the company. Target investors will be private equity investors with a minimum investment threshold of $10 million. What are the key points to make in an investor presentation?

Advice from the CEOs:

  • To demonstrate the company valuation, and the potential increase in value to investors, calculate the EBITDA trend for the last 3-4 years and project it out for the next 5 years.
    • The valuation is the whole company – not just the investment piece.
    • Show the increase in exit valuation with and without the target investment. Show impact.
    • Show revenue and EBITDA on the company’s current trend and what this will become with the investment.
  • An alternate view: Don’t focus on valuation. The company is profitable and growing. Pitch the plan and the financials associated with the plan. Let the potential investor come back with an investment proposal and terms. KISS – Keep It Simple Silly – take all the risk out.
  • There are periodic Shake the Money Tree events in Silicon Valley, sponsored by SVASE – Silicon Valley Association of Startup Entrepreneurs. Start attending these.
    • Ask for advice – not money. There is an adage in Silicon Valley is that if you ask for money you get advice; whereas if you ask for advice you get money.
    • There’s a subtle difference between the two asks. The point is that potential investors don’t just want to invest money. They want to be involved in the decisions as to how the company spends that money. By asking for advice, a potential investee demonstrates that they respect the opinions and input of potential investors and will listen to them.

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How Do You Gain Control of the Company? Three Steps

Situation: A CEO founded his company with a partner. The partner is no longer deeply involved but retains a voice in company strategy and finances. The CEO wants total control. It has become complex trying to run the company with an absent partner. How do you gain control of the company?

Advice from the CEOs:

  • Get a formal company valuation as soon as possible. The expense is paid by the company or split 50/50 between the CEO and founding partner.
    • This exercise will provide the information needed to run the company. It is a much more sophisticated exercise than simply valuing current company assets.
    • It will provide a good third-party valuation upon which the CEO and partner can negotiate a buyout of the partner’s interest or place a value on a silent partnership arrangement.
  • Once the company has a valuation, how is the conversation started?
    • First ask what the partner wants. His response will help frame the discussion.
    • It’s OK to let the partner know that the current arrangement is not working for you.
    • As silent partner, instead of a salary the partner just gets checks – monthly, quarterly or whatever – based on net profits (EBITDA – Earnings before interest, taxes, distributions and adjustments).
    • The CEO’s salary is included in the expenses of the business.
    • If it is too painful to initiate the discussion on your own, hire someone to help you.
  • Once the CEO has control of the company, create an organization chart, including the roles and responsibilities of the key positions in the organization.
    • First, decide what you do as CEO – or want to do.
    • For the other roles, either hire employees or consultants to help.
    • The E-Myth Revisited by Michael E. Gerber includes an example of how Thomas Watson did this as he founded IBM.
  • This process can have surprising results. Another CEO doubled the size of the company after buying out his founding partner’s position. The partner turned out to be one of the top inhibitors to growth.

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How Do You Respond to a Purchase Offer? Five Thoughts

Situation: A company has been approached by a larger company that is interested in purchasing it. The purchaser wants to fill a niche that they don’t currently serve, but which is important to their growth. The CEO is concerned about what will happen to employees following sale of the company. How do you respond to a purchase offer?

Advice from the CEOs:

  • Questions for Preliminary Stage Research:
    • What valuation is the tipping point for an attractive offer by the buyer?
    • Determine the nature of the purchaser’s interest in the company and how it fits into their broader strategic picture. If their plan will dramatically change the market the company’s current market value may go down later relative to doing a deal with them today.
    • If the acquirer has a history of buying other companies, look at who they’ve recently bought, what they paid, and what kind of impact they had on the staff and culture of the companies purchased.
    • Check out the purchaser’s P/E ratio. If it is in the range the company’s desired multiple on EBITDA, a good deal is possible.
  • Temper the company’s response and approach to get the most from this experience.
    • Currently, assumptions about the acquirer make the offer appear unappealing. Ask questions to validate or challenge these assumptions.
    • Be open-minded so that the purchaser reveals more about themselves and the market than they would if they sensed a lack of interest in an acquisition.
  • How does the company protect itself during the inquiry and due diligence process?
    • Keep staff numbers and individuals, and customer lists close to the chest.
    • Have an LOI and ask for a breakaway clause before sharing significant information. 
      • Breakaway clause: if the two companies get into discussions and the potential acquirer decides to abandon the discussions, it will cost them $1M.
      • The potential acquirer may not agree to this, but it demonstrates that the company is serious both about the discussions and about preserving the confidentiality of its business information.
  • More Advanced Stage Questions and Research:
    • This looks like a strategic interest. If so:
      • Get assistance from an investment banker.
      • Look at what other alternatives may be available to the acquirer to assess the company’s potential value.
      • Any offer other than a high-multiple strategic valuation and offer should not be of interest to the company.
    • What restrictions will the acquirer put on the company? 
      • For example, if there is an earn-out value, will they give the company the freedom to operate to maximize this value?
    • Be careful with employee communications and how employees are informed of an outside interest. This can be difficult during due diligence.
    • If the founder remains with the company post-sale this could help lock in the value of the exit and assure the employees’ future.
  • Make the most of this opportunity.
    • Are there ways that the company can become better and smarter working with the acquirer?
    • Is there a relationship short of acquisition than would benefit the company like a collaboration or partnership?
    • Can a relationship short of sale enhance the company’s market presence and help the company to achieve national status more quickly?

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What Is a Favorable Exit Strategy? Three Points

Situation: A CEO is contemplating retiring in the next two years. The company is profitable but is primarily dependent upon a single large client for whom the CEO is the primary contact. Compared to national averages the company’s profitability is very favorable. The CEO questions whether his valuation of the company is reasonable. What is a favorable exit strategy?

Advice from the CEOs:

  • The principal question from the group is whether the anticipated valuation on exit will yield the financial rewards that the CEO requires.
    • The buyer will discount the value of the current business because the CEO is too important to the business, and because they will not assume that there is ongoing value to the current business beyond 2-3 years.
    • The best option is to sell to a buyer who wants entry into the key client. They will have reasons beyond the value of the company to pay a premium for this access.
    • For planning purposes put the value at 2-3 years of the cash that the CEO takes out of the company, discounted to present value plus some premium for the entry that the buyer seeks. Look at the dollars that this will yield and decide whether this sum is a satisfactory payment.
  • Concerning the company’s relationship with the key client:
    • The company’s reliance on the key client is two-fold – they are the key customer, and they drive the market which yields a premium price for the company’s products.
    • Purchasers do not like to be dependent on a single supplier. Their purchasing department will always be looking for alternative sources.
    • During the exit window it is critical to develop new customer relationships to sustain the company’s growth and reduce reliance on the single key customer.
  • If the key client is #1, who is developing technologies that will compete with the key client?
    • What are their markets?
    • Where are they going?
    • How are they trying to exploit the chinks in key client’s armor?
    • What can the company do to secure a vendor relationship with the companies who may replace the key client?

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How to You Generate a Predictable P&L? Three Solutions

Situation: The CEO of a consulting company is frustrated by lumpy revenue and profits. From quarter to quarter it has been difficult to predict either number. Unpredictability reduces options in valuation and exit exercises, as banks and acquirers favor predictability. How do you generate a predictable P&L?

Advice from the CEOs:

  • The objective is to construct a revenue base built on predictability, even if this is at lower margins. Given a predictable base, the company can complement predictable revenue and profits with higher dollar and margin opportunities as they arise.
    • Analyze the projects that the company contracts for both revenue and profitability. Some projects will be bread and butter situations which are more common and predictable, but which generate less revenue and profit per project. Others will be customer crisis driven. These latter projects will have higher revenue and profit, particularly if the company is the vendor of choice; the tradeoff is that the frequency of these contracts is unpredictable.
    • If the objective is predictability, the company’s base should be built on bread and butter projects. As the company grows, focus on this base. Customer crisis projects can then be added as they arise to bump both revenue and profit.
    • The objective will be to become one of the top 2-3 outside vendors of the choicest clients. Target projects may be ongoing maintenance of older projects in the client companies’ portfolios.
  • How would this model be pursued?
    • Focus on the company’s top 5 customers. Reduce risk by optimizing customer leverage as a proven entity and offer them strategic deals.
    • The focus is long-term project based with guaranteed delivery at lower cost.
    • Identify the fear or insecurity that exists within the customer and provide sleep insurance.
    • This model works well in the new economy – get lean, manage infrastructure size and cost, and grow with the economy.
    • Alternately, identify an area where the customer may not have enough resources and provide a solution that allows them to address this without adding additional personnel or by using existing personnel more efficiently.
  • Another option is to develop a virtual office model. Provide resources for $X per month, with an evergreen provision.

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Do You Give Equity to Board Members? Four Considerations

Situation: An early-stage company has a key advisor who is helping them to build a 3-5 year vision and plan. The company can’t afford to pay the advisor full-time but he’s interested in working one day a week or becoming a Board member. Should they give him equity as a Board member and under what conditions?

Advice from the CEOs:

  • Adding Board members increases complexity, especially when it comes to big decisions. Once an early stage company transitions from their start-up Board to a more formal Board with non-founder members, particularly when a significant number of the new members have strong corporate experience, the Board will take on a certain level of independence in corporate and compensation decisions. Be aware of this, as a larger more independent Board may make decisions that the founders would not make.
  • It is not irregular for Board Members to receive equity or options. If you want to grant options, you must undertake an initial company valuation exercise, followed by annual valuations. It is common to grant options with 4 year vesting on a monthly basis. Vested shares can be purchased at Day 0 price, with some period to exercise options following departure from company.
  • Seek an expert in Board operation and compensation. There are a number of advisors with deep experience in this area who can advise the company on standard practices for Board operation and compensation.
  • If the company decides that they are not yet ready for an expanded Board of Directors, another alternative is a Board of Advisors.

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